(June, 2005 release): The House has overwhelmingly voted to permanently repeal the estate tax in 2010. If the Senate concurs, the estate tax will be replaced in 2010 by a new capital gains tax. No pending legislation would either repeal the gift tax or increase the current $1 million gift tax exemption amount. However, President Bush advocates eliminating gift taxes as well.

As of 2010, the present step-up in basis to fair market value accorded at death would be replaced by a carryover basis provision. Heirs would be required to pay capital gains tax on inherited property if and when it was eventually sold. In some cases, the capital gains tax could exceed the estate tax it replaced.

Assets worth $1.3 million (and an additional $3 million for a surviving spouse) would be exempt from the basis rules. Executors could “cherry pick” assets having the lowest basis for the exemption. In any event, a determination of the historical basis of all estate assets and all subsequent adjustments to basis would be required. Although generous exemptions accompany the new legislation, basis step-up is deeply ingrained in the tax system. A similar carryover basis rule enacted in the 1970’s was so reviled by tax professionals that it suffered the rare fate of retroactive repeal.

The prospect of new carryover basis rules will likely cause life insurance policies to proliferate, since internal asset appreciation is not subject to capital gains tax; moreover, since policies are paid in cash, basis step-up is still effectively achieved.

The bill would also (i) sanction oil-and-gas exploration in portions of the Arctic National Wildlife Refuge (ANWR); (ii) allow small oil refiners (75,000 bbl/day) to claim favorable depletion deductions; (iii) provide tax credits for residential solar water heating and fuel cells, and for business fuel cell power plants; (iv) reduce the tax on diesel fuel by $.05/gallon; and (v) allow new personal energy credits to offset AMT liability.

President Bush supports (i) greater use of nuclear energy and more favorable tax treatment of nuclear decommissioning costs; (ii) extension of the EPA’s 1998 Clean Air Act attainment date; (iii) tax credits for renewable energy such as wind, landfill gas, and hybrid and fuel-cell vehicles; and (iv) oil-and-gas exploration of ANWR, the Outer Continental Shelf, Federal onshore lands, and Indian lands. However, noting high crude prices, the Administration does not share the House view that new taxpayer subsidies should be provided for oil-and-gas exploration.